Hicks on Keynes and the Theory of the Demand for Money

One of my favorite papers is one published by J. R. Hicks in 1935 “A Suggestion for Simplifying the Demand for Theory of Money.” The aim of that paper was to explain how to reconcile the concept of a demand for money into the theory of rational choice. Although Marshall had attempted to do so in his writings, his formulations of the idea were not fully satisfactory, and other Cambridge economists, notably Pigou, Lavington, Robertson, and Keynes, struggled to express the idea in a more satisfactory way than Marshall had done.

In Hicks’s introductory essay to volume II of his Collected Essays on Economic Theory in which his 1935 essay appears, Hicks recounts that Keynes told him after reading his essay that the essay was similar to the theory of liquidity preference, on which Keynes was then working.

To anyone who comes over from the theory of value to the theory of money, there are a number of things which are rather startling. Chief of these is the preoccupation of monetary theorists with a certain equation, which states that the price of goods multiplied by the quantity of goods equals the amount of money which is spent on them. The equation crops up again and again, and it has all sorts of ingenious little arithmetical tricks performed on it. Sometimes it comes out as MV = PT . . .

Now we, of the theory of value, are not unfamiliar with this equation, and there was a time when we used to attach as much importance to it as monetary theorists seem to do still. This was in the middle of the last century, when we used to talk about value being “a ratio between demand and supply.” Even now, we accept the equation, and work it, more or less implicitly, into our systems. But we are rather inclined to take it for granted, since it is rather tautologous, and since we have found that another equation, not alternative to the quantity equation, but complementary with it, is much more significant. This is the equation which states that the relative value of two commodities depends upon their relative marginal utility.

Now to an ingénue, who comes over to monetary theory, it is extremely trying to be deprived of this sheet-anchor. It was marginal utility that really made sense of the theory of value; and to come to a branch of economics which does without marginal utility altogether! No wonder there are such difficulties and such differences! What is wanted is a “marginal revolution!”

That is my suggestion. But I know that it will meet with apparently crushing objections. I shall be told that the suggestion has been tried out before. It was tried by Wicksell, and though it led to interesting results, it did not lead to a marginal utility theory of money. It was tried by Mises, and led to the conclusion that money is a ghost of gold – because, so it appeared, money as such has no marginal utility. The suggestion has a history, and its history is not encouraging.

This would be enough to frighten one off, were it not for two things. Both in the theory of value and in the theory of money there have been developments in the twenty of thirty years since Wicksell and Mises wrote. And these developments have considerably reduced the barriers that blocked their way.

In the theory of value, the work of Pareto, Wicksteed, and their successors, has broadened and deepened our whole conception of marginal utility. We now realize that the marginal utility analysis is nothing else than a general theory of choice, which is applicable whenever the choice is between alternatives that are capable of quantitative expression. Now money is obviously capable of quantitative expression, and therefore the objection that money has no marginal utility must be wrong. People do choose to have money rather than other things, and therefore, in the relevant sense, money must have a marginal utility.

But merely to call their marginal utility X, and then proceed to draw curves, would not be very helpful. Fortunately the developments in monetary theory to which I alluded come to our rescue.

Mr. Keynes’s Treatise, so far as I have been able to discover, contains at least three theories of money. One of them is the Savings and Investment theory, which . . . seems to me only a quantity theory much glorified. One of them is a Wicksellian natural rate theory. But the third is altogether more interesting. It emerges when Mr. Keynes begins to talk about the price-level of investment goods; when he shows that this price-level depends upon the relative preference of the investor – to hold bank-deposits or to hold securities. Here at last we have something which to a value theorist looks sensible and interesting! Here at last we have a choice at the margin! And Mr. Keynes goes on to put substance into our X, by his doctrine that the relative preference depends upon the “bearishness” or “bullishness” of the public, upon their relative desire for liquidity or profit.

My suggestion may, therefore, be reformulated. It seems to me that this third theory of Mr. Keynes really contains the most important of his theoretical contribution; that here, at last, we have something which, on the analogy (the approximate analogy) of value theory, does begin to offer a chance of making the whole thing easily intelligible; that it si form this point, not from velocity of circulation, or Saving and Investment, that we ought to start in constructing the theory of money. But in saying this I am being more Keynesian than Keynes [note to Blue Aurora this was written in 1934 and published in 1935].

The point of this extended quotation, in case it is not obvious to the reader, is that Hicks is here crediting Keynes in his Treatise on Money with a crucial conceptual advance in formulating a theory of the demand for money consistent with the marginalist theory of value. Hicks himself recognized that Keynes in the General Theory worked out a more comprehensive version of the theory than that which he presented in his essay, even though they were not entirely the same. So there was no excuse for Friedman to present a theory of the demand for money which he described “as part of capital or wealth theory, concerned with the composition of the balance sheet or portfolio of assets,” without crediting Keynes for that theory, just because he rejected the idea of absolute liquidity preference.

Here is how Hicks summed up the relationship in his introductory essay referred to above.

Keynes’s Liquidity theory was so near to mine, and was put over in so much more effective a way than I could hope to achieve, that it seemed pointless, at first, to emphasize differences. Sometimes, indeed, he put his in such a way that there was hardly any difference. But, as time went on, what came to be regarded in many quarters, as Keynesian theory was something much more mechanical than he had probably intended. It was certainly more mechanical than I had intended. So in the end I had ot go back to “Simplifying,” and to insist that its message was a Declaration of Independence, not only from the “free market” school from which I was expressly liberating myself, but also from what came to pass as Keynesian economics.

Kevin, Thanks for catching that one, I’ll make the change. It’s been so long since I read A Market Theory of Money, I have no recollection of it. But Hicks wrote admiringly of Hawtrey in several other places as well.

To be fair to Friedman he was entirely reframing the question from ‘why is money held?’ to ‘given money is held, what are its empirical determinants?’ so in that sense his theory is a different one from that of Keynes.

And again to be fair regarding the money demand independently formulated at Chicago issue, Friedman renounced this point himself in his 1974 response to Patinkin.

Johnson contended, perhaps unfairly, that Friedman just made this tradition up to legitimize his monetarist counter-revolution. I found a possible alternative explanation for his error in a footnote in a Laidler paper:
‘Robert Leeson (2003, Vol. 2, p. 484) has suggested that Friedman’s erroneous recollections of a Chicago version of the quantity theory conceived of as a theory of the demand for money might be explained by the fact that his own lecture notes from 1932 show that Lloyd Mints paid attention that year to Keynes’ recently published Treatise on Money (1930) which embodied many elements of the Cambridge version of the quantity theory tradition but also expounded a version of what, in the General Theory (1936), would become “liquidity preference” theory.’

Friedman 1974 however does stress the importance of Chicago was the home of a coherent alternative to the Austrian/Keynesian policy choices. Here again though Chicago was not unique (e.g. 12/24 signatories on the 1932 Harris Foundation manifesto were not Chicago). Also, Laidler argues convincingly that Currie should be recognized as co-pioneer of the policies of Friedman’s Chicago tradition even though he was influenced not by Fisherian QT but by Hawtrey’s (his PHd supervisor) Cambridge version.

But while the monetary-cycle explanation was not unique to Chicago in the 1930’s, I guess the thing that really makes it unique is that it survived while Harvard was overrun by Alvin Hansen and the Keynesians in 1936.

Thank you for the reference David Glasner, but are you sure you’re not confusing Hicks’s preface with the actual text?

Also, I believe I pointed you to the work of a young French scholar who is doing research on J.R. Hicks and J.M. Keynes, and also on Ralph G. Hawtrey a while ago. You said you’d get back to me on it, but it seems you have been busy. Would you like me to send to you a link to her profile and perhaps her scholarship?

George, I think I see the distinction that you are making, but I am not sure why it matters. The demand for money is the demand for money and it is governed by the basic factors enumerated by Keynes in Chapter 17 of the GT, which Friedman, in essence, restates.

Friedman admitted that there was no Chicago oral tradition pertaining to the demand for money, but then introduced the Chicago quantity theory policy tradition as if that in any way was relevant to his own characterization of the quantity theory as a theory of the demand for money.

Your point about Friedman’s lecture notes from Mints’s class are certainly interesting and may the origin of Friedman’s mistake, but it only confirms that Friedman was more deeply influenced by Keynes than he admitted. Chicago was unique in many ways, but the point is that Friedman mischaracterized what was unique about it.

Blue Aurora, As I recall, that part was from the text of the original article. Yes why don’t you send me a link, thanks.

David Glasner: I see…I’ll have to see if there are any earlier appearances in text which predated the run-up to the publication of The General Theory. Also, I sent to you the links to the young scholar’s stuff in question via e-mail.

“So there was no excuse for Friedman to present a theory of the demand for money which he described “as part of capital or wealth theory, concerned with the composition of the balance sheet or portfolio of assets,” without crediting Keynes for that theory, just because he rejected the idea of absolute liquidity preference.”

Mind you, Keynes never credited Lavington either for his earlier contribution to the theory of the demand for money.

Pulling out my Laidler here…

From Fabricating the Keynesian Revolution (pg 87):

“Lavington’s analysis of endogenous fluctuations of velocity was based upon a significant extension of the Marshall-Pigou cash-balance approach to the demand for money into what would later be called (by Keynes) liquidity preference theory, a contribution which received its fullest treatment in Lavington’s study The English Capital Market (1921).”

Here is an interesting note from the same page:

“Though Keynes never referred to Lavington, as noted in footnote 7, Dennis Robertson was aware of the significance of that particular contribution, which, crucially, he drew to the attention of John Hicks. See Hicks (1935). See also Bridel (1987) for an appreciative discussion of the importance of that aspect of Lavington’s work to the development of Cambridge monetary thought. It should nevertheless be noted that important elements of Lavington’s formulation of the theory of the demand for money, along what we would now call the ‘precautionary motive’ lines, were anticipated by Francis Edgeworth (1888), Carl Menger (1892), and Wicksell (1898).”

…as well as note 7 on page 83:

“Even though Lavington had been Keynes’s pupil, there is no mention of Keynes here or anywhere else in Lavington’s writings, as far as I am aware. Keynes, in his turn, seems to have ignored Lavington just as completely. It would be interesting to know why.”

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.